Common Mistakes Made With Real Estate Errors and Omissions

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Gallagher
Real Estate &
Hospitality
Common Mistakes Made With Real Estate
Errors and Omissions Insurance
MARCH 2015
Common Mistakes Made With Real Estate Errors and
Omissions Insurance
Complex real estate transactions gone awry can produce lengthy litigation. Even low value, frivolous situations can
quickly become protracted litigation with large dollars being spent on what seems like endless defense. Real estate errors
and omissions or miscellaneous professional liability insurance is a very good solution and can protect the balance sheet
of the Real Estate Operating Company (REOC) and cover those defenses costs. Unfortunately, there are many pitfalls
frequently created by insurance brokers who do not specialize in designing risk transfer products specifically for real
estate firms.
Real Estate Risks
OPERATIONAL RISK
Owned Managed
Property
3rd Party Property
Management
Tenant Rep–
Sales & Leasing
FINANCIAL RISK
Construction Management–
Project Management
Investment Advice
Selling Broker/Dealer
Fund Creation
Loan Origination
Design/Development
Asset Management
Portfolio Management
Asset Selection
Insurance Policies
Development
Miscellaneous Professional Liability
Investment Advisor Professional Liability
Architects and Engineers
Professional Liability
Construction Management
Broker/Dealer Professional Liability
Fund Advisor Liability
Employed Lawyer Liability
Cyber Liability
Rarely do boiler plate insurance products line up well with a real estate company’s total risk profile. While a REOC
may have both “operational” and “financial” risks on their balance sheet, most insurance companies prefer to bundle
only homogenous risks into specialty polices and segment these risks into different categories (e.g., investment advice
verses third party management). These separate polices frequently contain many exclusions for operations assumed to
be covered by the REOC firm or a different insurance policy and are underwritten by completely separate departments
or in some cases, different insurers all together. This can frequently cause uncovered losses as they fall through the
cracks — if the placing insurance broker does not understand the risk profile and look out for the REOC’s best interest.
If appropriate risk transfer is not well thought out in advance, it can lead to consternation at the absolute worst time.
In an ideal situation, this would lead to double coverage under multiple policies. Frequently it is the opposite situation,
where large coverage gaps exist in the insurance and what many assumed to be covered simply is not.
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Common Mistakes Made With Real Estate E&O Insurance
2
Where to start?
The best place to start is to use good risk management
techniques to reduce the risk of litigation in the first place.
These measures include the consistent use of industrystandard contracts and disclosure forms, and regular
training for licensees on best practices for minimizing risk.
Experienced counsel specializing solely in your specialty
area of real estate is key.
Companies with a mature risk management and legal
department can benefit from a knowledgeable broker
specializing in risk transfer for real estate companies, and for
smaller companies it is even more critical to have the right
representation. It is always important to have experienced
professionals bolstering your internal risk management
function and helping you navigate the myriad of products
that are required to appropriately address a real estate
company’s errors and omissions (E&O) risks. It is also
important that one broker handle all aspects of professional
liability, since several different policies may be involved and
must interact seamlessly to ensure proper coverage.
Why do I need Real Estate Errors and
Omissions Insurance?
The downside of not buying insurance is simply exposing
the balance sheet and ultimately the return to investors.
Insurance acts as a smoothing vehicle and lends greater
predictability to financial performance by minimizing
the unexpected costs of periodic litigation. The amount
of coverage a real estate professional requires should be
determined by the nature of the firm’s operations, and
whether the risk is primarily “operational” (meaning
management related) or “financial” (meaning investment
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related). The size of the transactions and the financial
complexity will be important considerations as well.
What Does Errors and Omissions Insurance
Cover?
There is no such thing as a “standard” E&O policy. All
are unique and therefore have different coverage grants
and exclusions. In general, the policy is designed to
pay for defense costs and the damages associated with
wrongful acts, errors or omissions arising out of what
you do for others in exchange for consideration. While
most REOC’s will spend considerable time underwriting
a transaction, even the most thoughtful professional can
be held liable for an error, omission or mistake. Defense
costs reimbursement for unfounded allegations is one of
the main benefits of an E&O policy. It is not uncommon
for REOC’s to spend hundreds of thousands of dollars on
defense costs for a matter that ultimately gets dismissed.
A claim under an E&O policy must allege negligence in
either the performance of or failure to perform professional
services. Errors and omissions insurance policies have a
specific limit of liability and usually include both defense
cost and damage awards or settlements within the limit of
liability. Keep in mind that almost all E&O policies will
not cover intentional, fraudulent or illegal activities but
they will defend against these allegations until they are
proven in a court of law.
Lawsuits aren’t just about negligence; they are about
allegations of negligence. Many innocent parties are
brought into a suit simply because they were part of a
transaction.
Common Mistakes Made With Real Estate E&O Insurance
3
Types of Errors and Omissions Insurance for
Real Estate Companies
The most common types of Errors and Omissions
coverages needed for a typical REOC falls into four
general categories: 1. Investment Advisory Errors and
Omissions, 2. Real Estate Errors and Omissions, 3. Cyber
Liability (security and privacy liability) and 4. Employed
Lawyers Liability.
Investment Advisory Errors and Omissions are the
exposures created when a REOC is investing money on
behalf of third parties or acting as a broker/dealer — this
can be through a fund or on a separate accounts basis.
It may be through a general partner liability structure,
where investors purchase limited partnership units, or a
wide variety of other structures. The potential risk is that
an investor may not be satisfied with the investing results
and as a result brings suit for acts, errors, omissions,
misstatements, or misleading statements. We have seen
several instances when property values cycle down due
to economic conditions, but investors bring suit as a
means of recourse to recoup their investment. Some
underwriters use the term “asset management” to refer to
this exposure, while other underwriters use the same term
for real estate errors and omissions, described below. This
is another example of why having a knowledgeable broker
is imperative.
resources. Currently, there are only a few markets who will
offer comprehensive coverage, but Gallagher continues to
work with insurers to create new products that will cover
all aspects of services provided.
Cyber Liability insurance is a common insurance term
that includes many different types of potential exposures,
including security and privacy liability, media liability,
first party notification and credit monitoring expense.
A comprehensive Cyber Liability policy will include
coverage for all these exposures. Real estate companies
have increased exposure due to their collection of tenant
and/or investor information in addition to employee data.
Employed Lawyers insurance policies cover the exposures
of individual attorneys providing legal services to their
company. There may also be additional exposure to the extent
the attorney is providing consultative services to tenants or
other clients. These policies usually need to be amended to
specifically cover the needs of the REOC depending on what
services the legal department is providing.
Why the distinction from “operational risk”
and “financial risk?”
The main reason the distinction is made is a result of the
divide in the applicable departments at the insurance
company. None of the insurers who consider real estate
errors and omissions use one department to underwrite
The most common types of Errors and Omissions coverage needed for a typical REOC falls
into four general categories: 1. Investment Advisory Errors and Omissions, 2. Real Estate
Errors and Omissions, 3. Cyber Liability (security and privacy liability) and 4. Employed
Lawyers Liability coverage.
Real Estate Errors and Omissions are exposures from
any services being provided. These suits can result from
a sale, lease or property management service, mortgage
broker, real estate agent or broker, human resources
services, administrative, marketing, strategic management
support, systems support, bookkeeping, facilities support,
development management, construction management,
design services, etc. The exposures are as diverse as the
firms themselves, and the insurance policies must be
carefully manuscripted to ensure comprehensive coverage.
For example, many insurers offer policies for property
management, but those same insurers will exclude
construction, development and mortgage broking. Other
insurers will offer mortgage broking, but not human
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“financial” exposures and “operational” exposures. The
financial exposures are segregated to a group of underwriters
who also review mutual funds, banks, private equity
companies, broker dealers and venture capital companies,
and understand the complexity of financial transactions.
These underwriters review real estate investments just like
any other type of investment.
Conversely, the operational aspects of real estate exposures
are often underwritten by non-financial institutions or
“commercial” underwriters who also review consultants,
freight companies, architects and engineers, appraisers,
medical billing, payroll, staffing, etc. These underwriters
review real estate services provided just like those provided
Common Mistakes Made With Real Estate E&O Insurance
4
by any services firm. The issue we run into with real estate
is that these types of policies are generally written to be
very specific, with only a few services covered and all
others excluded. Real estate is particularly challenging
because many underwriters do not want to insure all of
the potential exposures on one commercial Errors and
Omissions liability policy.
Doesn’t My General Liability Insurance
Provide the Same Protection?
Commercial General Liability does not provide coverage
for errors, contract performance disputes or any other
professional liability issues. Additionally, most general
liability policies need an “accident” to trigger a bodily
injury or property damage. Most E&O losses arises from
“financial damages” and thus would never trigger a general
liability policy in the first place.
What are some examples of types of claims?
1. Failure to maintain the property as contracted —
results in loss of property value to owner.
2. Failure to properly secure premises, e.g., lack of
security on managed premises resulted in assault on
tenant/visitor.
3. Commingling or mishandling of funds; e.g. failure
to collect/properly account for rent monies.
4. Incorrectly processing an eviction order.
5. Risk management and/or failure to maintain proper
insurance.
6. Personal injury exposures — especially wrongful
eviction or discrimination.
7. Possible conflict of interest from ownership in
property being managed.
8. Negligence of subcontractors.
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Common Mistakes Made With Real Estate E&O Insurance
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Gallagher
Real Estate &
Hospitality
Two Pierce Place
Itasca, IL 60143-3141
About the Authors
Caley LaRue is the Co-National Director for the Real Estate & Hospitality Practice for Management and Professional
Liability. He has over twenty years of experience in the insurance industry working with Fortune 100 through Fortune
1000 publicly traded companies as well as large privately held and partnerships structured organizations. He leads
a national in scope brokerage team focused on Directors & Officers Liability, Fiduciary Liability, Kidnap/Ransom
and Extortion, Error’s & Omission’s as well as Employment Practices Liability. He specializes in understanding and
coaching clients on complex merger and acquisition transactions, significant claim negotiations as well as operational
and construction risks related to real estate exposures.
Emily Loupee is the Co-National Director for the Real Estate & Hospitality Practice for Management and
Professional Liability. She is responsible for educating the entire national and international real estate team on the
management and professional liability exposures. In addition, she also educates the entire Management Liability
Practice group on real estate specific concerns and issues.
For more information, contact:
Caley LaRue
Arthur J. Gallagher & Co.
[email protected]
15BSD27300A
Emily Loupee
Arthur J. Gallagher & Co.
[email protected]
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